Investors looking for a growth gem in the technology space have looked to companies like Amazon.com, Inc. (NASDAQ:AMZN), Facebook Inc. (NASDAQ:FB) and more recently Shopify Inc. (NYSE:SHOP) for companies that have established leading market positions in the up-and-coming e-commerce industry via unique platforms, an industry which many analysts point to as having the potential to disrupt today’s retail environment in its entirety.
With the recent acquisition of Whole Foods Market, Inc. (NASDAQ:WFM) by Amazon this past week, e-commerce is once again in the spotlight. Shares of SHOP are expected to remain in focus over the coming weeks following this news, as it appears even more crossover between e-commerce and traditional bricks-and-mortar retail remains feasible, with the demand of e-commerce related stocks such as SHOP likely to be sustained.
In this article I’m going to dive into a few fundamental factors that may lead to the continued rise of SHOP stock, as well as few cautionary factors to take into consideration when thinking about how SHOP may fit into an investment portfolio at today’s valuation levels.
SHOP Stock Is a Growth Investor’s Dream
Shopify is growing its cloud-based multi-channel (e-commerce) platform at breakneck speed, growing its year-over-year revenue on the order of 75%, with its Merchant Services Revenue increasing 92% year-over-year during the previous quarter.
The company’s focus on small- to medium-sized businesses, as well as the company’s recent partnership with Amazon have been catalysts that have driven SHOP stock substantially higher over the past year. Since the beginning of 2016, SHOP stock is up 337%. Since the beginning of this year, SHOP has already more than doubled.
The company’s agreement with Amazon allows SHOP customers to seamlessly integrate both AMZN and SHOP platforms, an agreement which stands to benefit both firms as each company continues to grow in importance as industry leaders.
The ability for small- to medium-sized business owners to migrate their e-commerce Amazon store to Shopify while retaining the services of Amazon to have orders serviced through the Amazon distribution platform, maintaining payment services and other web store services through Amazon, appears to be paying off for both companies.
The ability of SHOP’s management team to aggressively pursue available growth opportunities, and execute effectively on a complex and challenging growth strategy is something shareholders have seemingly priced into SHOP stock.
The valuation multiples garnered by SHOP are akin to those of other high-flying tech companies such as AMZN, and it appears investors believe the out-of-this-world revenue growth SHOP management has been able to generate since the company’s initial public offering (IPO) in mid-2015 are likely to continue into the medium to long term.
Growth Without Debt Presents Opportunities, Caution
Shopify has taken the traditional tech road to growth, an approach which has relied on seeking new equity raises at ever-increasing share prices to fuel revenue growth rates which exceed the rate of dilution, enticing investors to continue to buy equity at valuation multiples which continue to climb over time.
Growth companies in the technology space typically do not rely on raising debt early on in the company’s life-cycle due to a lack of established profitability and the threat that debt payments may inhibit the company’s ability to grow at lightning speed. With a growing appetite for SHOP shares in the market at increasing prices, additional equity offerings make sense.
The capital raised with these offerings appears to be put to good use by a competent management team that has sustained impressive results quarter-over-quarter and year-over-year of late.
That said, dilution remains one of the concerns of many long-term investors with the current growth strategy and funding model of SHOP. While the pie is expected to grow, owning a smaller percentage of the company’s future earnings over time due to continued equity issuances remains a long-term threat should SHOP growth rates slow down or profitability take too long to materialize.
As of the time of writing, Chris MacDonald had no position in any of the stocks listed.
